The Citigroup-promoted i-flex solutions made its debut on the bourses less than a year ago and its stock price performance has been superb to date.

Since its listing on June 28, 2002, the stock has gained 74.51 per cent even as the BSE IT index slumped 33.92 per cent.

The BSE Sensex lost 6.28 per cent during the same period. Most fund managers have given i-flex the pride of place in their portfolios even as they continue to be bearish on IT scrips in general.

One reason for this is simple: i-flex is the only domestic company to script a success story on the IT products side. It has achieved on the IT products side what Infosys accomplished in the services arena. Which brings up the question: How big can i-flex get, and what can go wrong?

i-flex's sound product-led business model has helped it record robust growth at a time when top-rung domestic IT companies, predominantly focused on the services side, have been virtually struggling to maintain the growth momentum.

The company's business model is centred on its homegrown banking product FlexCube, coupled with a steady services business.

FlexCube has been ranked the Number 1 selling banking package in the world for the year 2002 by International Banking Systems of the United Kingdom.

The product has modules catering to a host of banks and financial institutions, including commercial banks, investment banks, central banks and development banks.

i-flex's list of clients includes big names like the IMF, DBS and Union Bank of Switzerland.

The product has a geographical spread across 70-and-odd countries round the world, and has gained acceptance even in developed markets like the United States, Europe and Japan.

In the last quarter, the company added 12 new product customers and half of them were from these regions. The company's management expects a large part of the growth to come from these countries going forward. Its latest win is a contract for the global rollout from a major Japanese bank.

The market for banking products is huge. According to some industry estimates, nearly a third of IT spends in the US go to this financial services segment.

Major IT consultancy firms estimate the market for banking products to be in the region of $40 billion. Even if one were to disregard this figure and look at the relevant market size for the company, the opportunity seems to be immense.

A majority of banks across the world operate with legacy systems which may not be able to keep pace with the rate of change in technology. Given competitive pressures, they will have to upgrade.

While some of them will develop customised solutions in-house, more and more banks are looking at purchasing third party products off-the-shelf so that they can channelise energies in the core business.

"Every year 130-150 institutions have been changing their core systems. In markets like China, US, Japan and Europe this is likely to go on for the next 10 years. The trend now is to buy third party packages rather than developing systems in-house," says Rajesh Hukku, chairman and managing director, i-flex Solutions.

In the last fiscal, i-flex's product revenues constituted 64 per cent of total revenues. The business demonstrated strong growth, with revenues increasing 55 per cent. Generally, product-based businesses tend to be richer in terms of margins compared to services, essentially because of the pricing power they command.

This makes earnings more predictable in the long run. Besides, a product-based business model is more scaleable and allows the company to leverage on existing customers for more business.

The beauty of a product-based business model is that it is almost like an annuity after the company attains critical mass. The company earns a big chunk in the form of licence fees on implementation, and then earns an annual maintenance fee in subsequent years.

"While the licence fee flows straight to the bottomline, the parallel flows of implementation and further product sales to the existing client provide a substantial earnings upside," says an analyst with a foreign broking firm.

i-flex's licence fee contribution has been steadily rising on the back of good sales. Last year, these contributed 44 per cent to product revenues, up from 35 per cent the year before.

Besides, the share of revenues from annual maintenance charges has also increased steadily. In fiscal 2003, the contribution from AMCs was 17 per cent, up from 15 per cent the year before.

"That really shows the constant stream of annuity that will come into our revenue and increases the visibility of our revenues as we go forward," says i-flex CEO Deepak Ghaisas.

However, one concern about the products business is that it is lumpy. Says Amit Khurana, senior research analyst, Birla Sunlife Securities: "Earnings can be volatile on a quarter-on-quarter basis."

This is one reason why the last quarter ended March 2003, saw a sequential drop in the profits of i-flex's products business to Rs 41 crore (Rs 410 million) from Rs 54 crore (Rs 540 million) in the previous quarter.

While expenses remain steady, quarterly profits are driven by payments received for licences, which tend to be staggered.

Since licence fee milestones did not fall in the last quarter, there was a drop in the actual fees earned as compared to the first three quarters of the fiscal. On a yearly basis, the licence fee component has, however, gone up.

The coming quarters should be good. "Even though the licence fee is not recorded or accrued as a revenue, our tank size has substantially increased, and that is really a happy situation as far as the future is concerned," says Ghaisas.

The tank size is a measure of unbilled licence fees, an important measure of the visibility of the product business. It has increased to $37 million, up from $29.5 million at the end of the last quarter and up from $27 million at the end of March 2002.

For the year, this represented a 37 per cent increase in license fee open order book. "The current tank size should be enough to sustain the growth momentum in the next four quarters at least," says Khurana.

Another point in favour of a products-dominated business portfolio is that it tends to be non-linear. In services, revenues and costs are linked directly by a growth in head-count. Not so with i-flex.

In the last quarter, for instance, employee strength grew to 2,327, an increase of 295 from a year ago. This resulted in a 14 per cent increase in staff costs - far lower than the 46 per cent increase in revenues.

The biggest challenge for any products company is marketing - because selling expenses are often too high for small companies to afford.

However, this has not been much of a bottleneck for i-flex for two reasons. Firstly, its Citigroup affiliation has helped it gain acceptance faster. Secondly, it has been able to sell successfully through channel partners also.

Says Hukku, "On the marketing side, we are in an expansionary mode. Right now, our focus is on casting the net as wide as possible."

In September last year, the company launched a high-end business intelligence solutions product called Reveleus in the US market. The management claims that the initial reaction has been positive.

On the services side, the company is primarily dependent on Citi with nearly 60 per cent of its services revenues coming from there. Even as the company continues to get more business from Citi, it has been consciously increasing revenues from non-Citi clients in the last few years.

Last year, non-Citi clients contributed only 24 per cent to revenues; the number is up to 39 per cent currently. In the last quarter alone, the company added five new customers.

In line with other domestic service providers, i-flex's services revenues grew by 33 per cent last year. The lower growth was because of a sharp cut in billing rates by Citi.

Even though the management claims that there is no pressure on billing rates from Citi, some analysts are suspicious.

"Since the higher billing rates enjoyed by the company are not due to any competitive advantage, there could definitely be pressure on prices," says Gurunath Mudlapur, head of research, Khandwala Securities.

All put together, for FY 2003, i-flex recorded revenues of Rs 610 crore (Rs 6.10 billion), up 46 per cent compared to the previous year. Net profit was up 48 per cent to Rs 171 crore (Rs 1.71 billion).

During the year the company gained 59 new customers and its total customer base crossed the 400 mark across 93 countries.

The company also seems to have a tight leash on finances. At the end of the financial year, DSO (day sales outstanding) stood at 83 days as compared to 158 days at the end of last financial year.

Key concerns

Despite the recent diversification, the biggest concern is client concentration. Putting both products and services, the Citigroup contributes about 40 per cent of i-flex's total revenues, down from 44 per cent last year.

A substantial chunk nevertheless. However, some analysts argue that while in normal times this is a business risk, in uncertain times it can be a buffer.

The second concern is that competition may hot up in the sector. Both global and domestic competitors are getting aggressive in upgrading their products and services, ramping up marketing initiatives and signing alliances with global technology and implementation partners.

While TCS and Infosys have acquired significant orders from domestic banks recently, i-flex's main competitor, Temenos, has signed alliances with EDS and IBM to market its product.

"If Temenos slashes the price of its new product versions, it might affect i-flex's competitive position," says Khurana. But Hukku is defensive.

"In the IT business lead is very important. Some domestic companies have done well on the services side because they had a 20-year lead. We have a 6-7 year lead in this area and we know what it takes," he says.

Third, the company is focused only on the financial services vertical, which exposes it to fluctuations in the fortunes of the industry.

Even though the scope of FlexCube is quite large and the product has been very successful till now, i-flex's future primarily rests on the performance of this product alone.

Fourth, the company is not insulated from currency risk. "The rupee appreciation will eat into the company's profit margins," says Mudlapur. Last year, the company lost nearly Rs 4 crore (Rs 40 million) due to the appreciation of the rupee.

Despite these concerns, analysts say that the premium that the company's stock enjoys currently is well deserved. The reason why i-flex holds its own against titans like Infosys is because of its pedigree.

Barring Digital GlobalSoft, which is owned by US-based Hewlett Packard, and Hughes Software, there are no other companies with multinational parentage.

The Citigroup affiliation has been a major selling point for i-flex and has helped it gain acceptance in global markets sooner than it would normally have.

"The company's credible management with good bandwidth and its parentage justifies the valuation it enjoys," says a leading tech fund manager.

Most analysts have a target price in the range of Rs 1,100 for the stock in the medium term. However, it could see some selling pressure in June because shares acquired pre-IPO could hit the market after the end of the one-year lock-in period.

The consensus among analysts is that the i-flex growth story is far from over.